India has safeguards in place to mitigate risks from capital flows: IMF

“There are quite a few safeguards that the Indian economy has in terms of capital flows”

“There are quite a few safeguards that the Indian economy has in terms of capital flows”

India, which has received a record number of foreign direct investment in recent years despite the COVID-19 crisis, has put in place quite a few safeguards to limit the risks posed by capital flows, the International Monetary Fund said on Wednesday.

“Capital flows have several advantages. They finance the necessary investments. They help insure against certain types of risks. There are many benefits for countries to have capital flows in India and also benefits from receiving those capital flows,” the IMF’s first deputy general manager, Gita Gopinath, told reporters here.

The IMF released a paper on the Review of the Institutional View (IV) on the Liberalization and Management of Capital Flows on Wednesday. The IV was adopted in 2012 and forms the basis for consistent fund advice on capital flow policies.

The IV is intended to help countries reap the benefits of capital flows while managing associated risks in a way that maintains macroeconomic and financial stability and does not generate significant negative external spillovers. The Review introduces significant changes that extend the toolkit for policymakers, such as enabling the preemptive use of capital flow measures on inflows when financial vulnerabilities exist.

In response to a question, Ms. Gopinath noted that there are other types of financial risks associated with having large amounts of capital inflows.

“In the case of India, there are already a large number of capital restrictions in place. The Indian government uses these restrictions quite proactively in dealing with changes in the external environment. So by limiting the amount of external lending that the companies can make, that’s one tool they use. And they use it in response to changing external conditions.”

“So there are quite a few safeguards that the Indian economy has in terms of capital flows. But, of course, it is still in the process of liberalizing its capital accounts. And as his financial markets deepen, his financial institutions deepen, and could evolve into more, allowing for more forms of capital flows,” said Ms. Gopinath.

The top IMF official said capital flows are desirable because they can bring substantial benefits to recipient countries. But they can also lead to macroeconomic challenges and risks to financial stability, she said.

“The dramatic capital outflows we saw at the start of the global pandemic, and the recent turbulence and capital flows to some emerging markets after the war in Ukraine, are a strong reminder of how volatile capital flows can be and the impact this can have on economies. said Mrs Gopinath.

In the wake of the great financial crisis, where interest rates were long low in advanced economies, capital poured into emerging markets in search of high returns, she said. In some countries, this led to a gradual build-up of their foreign currency debt, which was not offset by foreign currency assets or hedges, she noted.

“When the descending tantrum hit and there was a sudden loss of appetite for emerging market debt, it led to serious financial problems in some markets. Lessons learned from such episodes and from a large body of studies are that in some circumstances countries should have the ability to pre-emptively curb debt inflows to ensure macroeconomic and financial stability,” said Ms Gopinath.

Accordingly, the major update to the policy toolkit released by the IMF is the addition of capital flow management measures and macroprudential policies that can be applied preemptively.

“But when used properly, these measures reduce the likelihood of a financial crisis in the event of a sudden reversal of capital input. This change builds on the Integrated Policy Framework, an IMF research effort to build a systematic framework to analyze policy options and trade-offs in response to shocks given country-specific characteristics,” she said.

The latest IMF report, she said, highlights the risks to financial stability that can arise from a gradual build-up of external debt obligations, especially when they cause currency mismatches, and limited and exceptional cases of foreign debt denominated in local currencies.

“Preemptive capital flow management measures and macroprudential policies to limit inflows can reduce external debt risks. But they should not be used in a way that leads to undue distortions, nor should they replace the necessary macroeconomic and structural policies or attitudes to keep currencies excessively weak,” said Ms Gopinath.

“Another update to our advice is to give special treatment to some categories of capital flow measures that fall under certain other international frameworks for security considerations. It also provides practical guidance for policy advice regarding capital flow measures, including identifying peaks in capital inflows and how to decide whether it is premature to liberalize capital flows,” she added.

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